Bank NPA may rise to 25-year high under severe stress, says RBI

Under the baseline scenario, it would be a 23-year-high. The gross bad loan ratio of banks stood at 7.5% as on 30 September 2020. The last time banks witnessed such non-performing assets (NPAs) was in 1996-97 at 15.7%, showed data from RBI. As the covid-19 pandemic wreaked havoc on the economy, leading to job losses, borrowers delayed repayments or failed to repay altogether.

RBI's stress tests typically show how bank asset quality will be affected under the baseline scenario and three adverse scenarios of medium, severe and very severe.

In its semi-annual Financial Stability Report, RBI said that stress tests are carried out on the basis of banks’ balance sheet positions, including slippage of loans into non-performing, profitability, capital and other relevant data reported by banks.

The stress test projections are close to where RBI had seen them in the last FSR in July. It had then said that bad loan ratios may rise 4 percentage points to 12.5% of total advances by March 2021 under the baseline stress scenario and to 14.7% under the very severely stressed scenario.

However, in view of the regulatory forbearances such as the moratorium, the standstill on asset classification and restructuring, the data on fresh loan impairments reported by banks may not be reflective of the true underlying state of banks’ portfolios, it said. Analysts are concerned that the Supreme Court order on 3 October, asking lenders to not classify certain accounts as bad, masks the true extent of stressed assets.

“These NPA projections are indicative of the possible economic impairment latent in banks’ portfolios, with implications for capital planning," it said.

In the past, RBI’s stress testing models have come under criticism from experts, citing difference between the forecasts and actual asset quality. Soumya Kanti Ghosh, group chief economic advisor, State Bank of India (SBI) wrote in November that RBI’s stress testing could have a significant upward bias.

RBI’s stress test projections on Monday came with several disclaimers and caveats. RBI said that considering the uncertainty regarding the unfolding economic outlook, and the extent to which banks use the debt recast benefit, the projected ratios are susceptible to change in a non-linear fashion. RBI had allowed banks to recast loans for borrowers whose cashflows have been affected by the pandemic and allowed such loans to be classified as standard despite their repayment norms being relaxed.

“By design, the adverse scenarios used in the macro stress tests are stringent conservative assessments under hypothetical adverse economic conditions. It is emphasised that model outcomes do not amount to forecasts," it said.

Owing to the stress, the capital adequacy ratio of banks is projected to drop from 15.6% in September 2020 to 14% in September 2021 under the baseline scenario and to 12.5% under the severe stress scenario. Worryingly, the stress test results indicate that four banks may fail to meet the minimum capital level by September 2021 under the baseline scenario, without factoring in any capital infusion by stakeholders. In the severe stress scenario, the number of banks failing to meet the minimum capital level may rise to nine, RBI said.

“At the aggregate level, banks have sufficient capital cushions, even in the severe stress scenario facilitated by capital raising from the market and, in case of PSBs, infusion by the Government. At the individual level, however, the capital buffers of several banks may deplete below the regulatory minimum," it said.